It has been about a month since the last earnings report for Discover (DFS Quick QuoteDFS - Free Report) . Shares have lost about 9.8% in that time frame, underperforming the S&P 500.

Will the recent negative trend continue leading up to its next earnings release, or is Discover due for a breakout? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at the most recent earnings report in order to get a better handle on the important drivers.

Discover Financial Q2 Earnings Miss, Revenues Up Y/Y

Discover Financial reported second-quarter 2023 adjusted earnings per share (EPS) of $3.54, which missed the Zacks Consensus Estimate by 3.3%. The bottom line dropped 10.6% year over year.

Revenues, net of interest expenses, of DFS climbed 20.2% year over year to $3,878 million. The top line beat the consensus mark by 0.1%.

The quarterly results received a blow from escalating operating costs and feeble contributions from the Digital Banking segment. Nevertheless, higher receivables growth, record deposit inflows and the solid performance of its Payment Services segment contributed to the upside.

Operational Update

Total operating expenses of $1,404 million escalated 15% year over year due to increased employee compensation and benefits expenses, marketing and business development costs, professional fees, and information processing & communications expenses. The figure came lower than our estimate of $1,404.9 million. However, operating efficiency (total operating expenses divided by revenues, net of interest expenses) improved 190 basis points (bps) year over year to 36.2% in the second quarter.

Interest expenses increased nearly four-fold year over year to $3,177 million in the quarter under review.

Discover Financial’s net income of $901 million tumbled 18.3% year over year.

Segmental Performance

Digital Banking

The segment reported a pretax income of $1,099 million, which fell 23% year over year in the second quarter. The decline was due to an increased provision for credit losses and elevated operating expenses, partly offset by growing revenues, net of interest expenses. The metric was lower than our estimate of $1,168 million.

Provision for credit losses increased more than one-fold year over year to $1,305 million.

Total loans rose 19% year over year to $117.9 billion in the quarter under review. Personal loans also grew 27% year over year. Credit card loans advanced 19% year over year, whereas private student loans improved 2% year over year.

Net interest income of $3,177 million climbed 22% year over year in the second quarter, thanks to increased average receivables and a higher net interest margin. The figure surpassed our estimate of $3,089.5 million by 2.8%. The net interest margin improved 12 bps year over year to 11.1%.

Payment Services

The segment's pretax income was $70 million, comparing favorably with the prior-year quarter’s income of $20 million. The metric beat our pretax income estimate of $55.6 million by 25.9%. The significant improvement came from higher net losses on equity investments reported in the prior-year quarter. Expanding PULSE and Diners Club volumes also contributed to the upside.

The Payment Services volume of $89.3 billion advanced 8% year over year in the second quarter. The PULSE dollar volume rose 10% year over year on improved debit transaction volume. Meanwhile, the Diners Club volume climbed 18% year over year, attributable to higher global travel and entertainment and corporate spending. However, the Network Partners’ volume dipped 10% year over year in the quarter under review due to reduced transaction volume.

Financial Position (as of Jun 30, 2023)

Discover Financial exited the second quarter with total assets of $138.1 billion, which climbed 20% year over year. The liquidity portfolio (comprising cash and cash equivalents and other investments, excluding cash-in-process) amounted to $20.9 billion, which rose 29% year over year.

Borrowings increased 1% year over year to $20.2 billion. Total liabilities of $124.2 billion advanced 23% year over year at the second-quarter end. Total equity rose 2% year over year to $13.9 billion.

Share Repurchase Update

In the reported quarter, Discover Financial bought back 6.8 million common shares worth $700 million. Shares of common stock outstanding decreased 2.6% sequentially.

Concurrently, the management has decided to pause share repurchases as an internal review of corporate governance, risk management and compliance is pending.

2023 Guidance

Management forecasts loan growth in the low to mid-teens range for this year, unchanged from the earlier guidance. In 2022, loan growth increased 20% year over year.

The net interest margin is forecasted at 11%, in line with the 2022 reported figure.

Operating expenses are anticipated to rise in low double digits against the earlier expectation of less than a 10% rise from the year ago figure.

The average net charge-off rate is estimated to be 3.4-3.6% compared with the prior mentioned 3.5-3.8%. The mid-point of the revised outlook stands higher than the 2022 figure of 1.8%.

How Have Estimates Been Moving Since Then?

In the past month, investors have witnessed a downward trend in estimates review.

VGM Scores

At this time, Discover has a subpar Growth Score of D, however its Momentum Score is doing a lot better with a B. Charting a somewhat similar path, the stock was allocated a grade of A on the value side, putting it in the top 20% for this investment strategy.

Overall, the stock has an aggregate VGM Score of B. If you aren't focused on one strategy, this score is the one you should be interested in.

Outlook

Estimates have been broadly trending downward for the stock, and the magnitude of these revisions indicates a downward shift. Notably, Discover has a Zacks Rank #3 (Hold). We expect an in-line return from the stock in the next few months.